The failures of Silicon Valley Bank (SVB) and Signature Bank, and the Federal Deposit Insurance Corp.'s about-face on covering uninsured deposits brings to light one of the inequities in the FDIC's previous approach to bank failures. Essentially, to obtain the lowest cost resolution, the FDIC historically did not cover all uninsured deposits. This nostrum has been adopted into statute, absent a finding of a systemic risk resulting from the failure to protect all of the funds on deposit, as occurred with SVB and Signature.
The notion that depositors should police the banking system has been couched in the concept of "moral hazard." Essentially, the thought was that if there were no downside risk, depositors would chase higher rates to problem banks. Consequently, problem banks would continue to grow, thereby compounding the challenge of resolving them.
This concept, to the extent it ever made sense, needs to be tossed onto the ash heap of history. We have seen that regulators can be surprised that they missed warning signs of problems even in the case of SVB and Signature, both of which had extensive examinations, examiners in residence and extensive reporting. All of that supervisory oversight is meant to provide regulators with real-time risk indicators.
Depositors have no such access to information about the condition of the banks where they deposit their money. Yet, depositors are supposed to identify warning signs and stay away? Or, if they do see those warning signs, vote with their feet? Isn't that the very definition of a bank run? In a digital age, banking regulation needs to move at the speed of Twitter.
Well, what about moral hazard? Rules are already in place to prevent "problem" banks from raising the interest rates they offer in order to continue growing.
Bank regulators provide bank management with a nonpublic "CAMELS" rating based on their assessment of its (C)apital adequacy, (A)ssets, (M)anagement capability, (E)arnings, (L)iquidity and risk (S)ensitivity.
Presumably, the regulators downgraded the CAMELS rating of both SVB and Signature. Such downgrades potentially subjected those banks to Prompt Corrective Action (PCA), which limits rates problem banks can pay and effectively eliminates their ability to access brokered deposits. Thus, rather than grow, problem banks shrink as the regulatory vise tightens.
However, even if moral hazard exists, is it good policy to require citizens and small businesses to underwrite their banks? Do they have the information and sophistication to do so? Is that an appropriate use of their time and skills? We have seen the potential devastation that can result from making uninsured depositors bear part of the cost of deposit resolutions. Businesses miss payroll, rent goes unpaid, capital investment ceases, contracts are breached. It is simply a negative lottery that catches the unaware. It is ethically and economically wrong.
In light of the market turmoil that followed the closing of IndyMac back in 2008, the FDIC instituted the Temporary Liquidity Guarantee Program (TLGP). The TLGP guaranteed 100% of deposit balances at all U.S. transaction accounts. A new TLGP is needed now. Only this time it needs to be permanent. Deposit assessments will need to go up to pay for it. The president, secretary of Treasury, and the FDIC chair have made clear that banks will pay for Silicon Valley and Signature. So, pay more on an ad hoc basis to cover the enviable bank runs or pay over time? Either way, banks will get the tab.
Eliminating bank runs now and forever is worth the price. We can question the FDIC's wisdom in eliminating the TLGP, but that train has left the station. The FDIC needs to readopt it and make it permanent.
